Question

At time zero the spot rate is $1.60 per GBP. Assume that next year the U.S. inflation will be 3 %, and British inflation 4%, what is the expected exchange rate at year end?

Answer: $1.5846/GBP

Assume that next year the U.S. inflation will be 3 %, and British inflation 4%. And the British Pound depreciates 7 % over the year. What is the real exchange rate q, at year end?

Answer: ???

Answer #1

Spot rate 1 GBP = | $ 1.60 |

Inflation in U.S. = | 3% |

British inflation rate = | 4% |

Forward rate = 1.60 * (1+0.04)/(1+0.03) | |

$1.5846 | |

GBP Actual depreciation rate = | 7% |

If one currency, percentage is adjusted in reverse currency/opposite currency from spot rate. | |

Spot rate 1 GBP = | $ 1.60 |

Less : Depreciation 7% | |

Real exchange rate = 1.60 * (1-0.07)= | $1.4880 |

So, real exhange rate is 1GBP = $1.4880. | |

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